Getting ready for the dollar’s fall

August 20, 2009

Agnes Crane It just won’t go away, this needling worry about the U.S. dollar losing its coveted top-dog status.

No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency — namely there’s just no alternative — for perhaps decades to come.

Yet, in a world where once-rock-solid assumptions quickly turn to dust, investors should keep an eye on the dollar since changing perceptions are chipping away at its cherished status as currency to the world.

Much of the debate so far this year has centered on creating an alternative to the U.S. dollar, championed by China and Russia as a way to wean the world off its dependence on the U.S. as well as buffer individual nations against the missteps of those in developed world. Most recognize creating a new currency will take years and the chances of an existing currency, like the yuan, usurping the dollar anytime soon are remote.

But that doesn’t mean big money isn’t starting to prepare for world in which the buck isn’t the currency of choice.

Curtis Mewbourne, a portfolio manager at PIMCO, has suggested that investors diversify away from the dollar and to move into other currencies, especially those in emerging markets.

“And while we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” he wrote in an article published on PIMCO’s website.

Notwithstanding its big bounce during the financial maelstrom last year, the dollar has been on downward trajectory for most of this decade. The U.S. dollar index, which currently stands around 78, once traded well above 100. In the early days of the dollar’s decline, currency traders worried about general diversification where central banks with big dollar reserves would begin to shave off a small portion of their holdings and exchange them for something else like euros.

The financial crisis, however, woke the world up to just how vulnerable those squirreling away dollars — like China and Russia — were to the fortunes of the United States. The bulk of the world’s currency reserves are in dollars, with the euro still a distant second. Foreign central banks, however, could hardly start selling dollar-denominated assets to limit their exposure because such sales would cause prices on their remaining holdings to fall further.

So far, calls for alternative currencies have been seen as political posturing for both international and domestic audiences alike, but the United States. has a lot to lose if it ever turns into something more concrete.

That’s because the loss of reserve status means, among other things, that the United States would lose a crucial crutch that has allowed it to borrow its way into prosperity as well as out of depression with relative impunity. Foreign investment in dollar assets have helped keep a cap on interest rates even though the government’s borrowing binge in recent years has brought new meaning to the word stimulus.

In an op-ed published in the New York Times today, Warren Buffett railed against the flowing red ink that will push the nation’s debt to roughly 56 percent of GDP from 41 percent in this fiscal year.

Presumably this is something that has also caught the eye of foreign investors.

While the greenback is likely to stay on top for some years, persistent concerns about its reserve status and moves to diversify away from it could usher in a new era for U.S. borrowers, public and private alike — a more painful one where debt costs can no longer be offset by the kindness of foreign investment.

44 comments

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2008 World nations by nominal GDP (USD millions):

Japan: 4,840,000

China: 4,200,000

India: 1,237,000

Germany: 3,820,000
France: 2,978,000
England: 2,787,000
Italy: 2,399,000
Spain: 1,683,000
-Total- 10,967,000

USA: 14,330,000

The Yuan as a reserve currancy? Pffff.

Posted by Hmmm | Report as abusive

Excellent accounting, short and sweet ! Does that include foreign GDP ? Also, please no supra-currency, only consolidated time-zoned currencies! Now we need to cap all arguments with Purchase Power Parity

Posted by Hour glass | Report as abusive

I’m thinking that a Japanese type scenario is still possible: with the US trying to inflate itself for decades! Yes decades out of debt and deflation. I struggle to see that any US president will allow retail sales to slump – to such an extent that it will take away the excess in the US economy: $2 trn. of junk companies.

I feel the US is heading the same way as Japan: right into a debt trap. Now what happened to the Japanese currency? It was traded up and down by currency speculators. Yet its value never recovered. And neither could the Japanese show consistent growth or a persistent rising stock market. I think this is possible. Very possible. Much like someone that is in heavily in debt, yet only survives from month to month. With spending spikes now and then.

Posted by Nasdaq7 | Report as abusive

I keep reading articles like this which still seem to use the same old tired arguments concerning dollar status. This is very disappointing. A possible look at the real prevailing strategies used by China and other creditor nations easily reveals that the dollar has many enemies:

* According to a MarketWatch article, China has pulled all her gold bullion holdings from London and is moving them to a new high Security location near the airport in Hong Kong. This may be China’s own attempt to start her own bullion market in the Far East. This action also clearly restricts and damages the London Bullion Market’s gold leasing capabilities. The Gulf States have also done the same.

*China kicked off issuing her own Treasuries on Sept 28 of this year. These bonds are a direct competitor to US Treasuries.

*The Chinese govt is now discreetly buying gold from her own gold mines after suddenly becoming the largest producer of gold in the world.

*The Chinese people can now buy as much gold and silver as they like — all 1.3 billion of them. This is being heavily promoted by the Chinese govt.

*The Chinese govt is slowly buying gold on th markets. Every time the uS govt dumps dollars onto the gold markets, China just buys gold safely in the dips with her dollars. Therefore, the US has lost control of the gold price and has therefore lost control over dollar value. The Chinese are now in control of the greenback.

* China appears to be returning to a partial gold standard. If China controls the gold markets as well as backs her Yuan with gold, the strength and stability of the Yuan will be untouchable and unassailable when compared to other world fiat currencies.

*China’s own sovereign wealth fund — China Investment Corporation(CIC) — has spread its investments out rapidly and very effectively, investing around the world mainly in extractive commodity industries. The CIC has alot of weight to throw around — $300 billion — and, amongst others, has been investing heavily in the oil and precious metals markets. Effectively, China’s CIC fund is dumping dollars for gold and other more worthy hard asset investments now.

*It appears that other world central banks have also begun buying gold now, as a hedge against the China gold plays.

*Recently, in an UK Independent article called “The Demise of the Dollar”, the countries of China, Russia, France and the Gulf states all openly announced that they would be dumping the petro-dollar for the euro. Iran will also be doing the same.

In terms of economics and the markets — particularly pertaining to the adverse affects on the dollar — these are certainly not trivial economic events.

If the author would bother to actually research what’s really going on with the dollar, she could perhaps put 2+2 together and form a believable opinion. I’m not saying that all this will happen quickly, all I’m saying is that the dollar is well on its fading way, and will probably end up, after some years, as merely a regional currency amongst equals as opposed to being the top dog currency.

Posted by Bill Jencks | Report as abusive